In a world of low default rates, the yield on high yield bonds is generally a good guide to future returns. That’s certainly been the experience of the last ten years. Global high yield has not been immune to recent market turbulence and yields in excess of 6% are now readily available – without having to chase lower-quality investments.
There are four previous instances where the US high yield market has moved, from a low base, through that magic 6% yield level. These four instances, in 2013, 2014, 2018 and 2020, produced annualised returns over the medium and long-term that average around 6%.
If you invested in October 2014, within a year you had bumped into the commodities driven sell-off of late 2015; investors in June 2013 met this after three years. Note that if you had excluded the very topical energy sector back in October 2014, you would have made a positive total return over one year. Investing on 12th March 2020, before we had appreciated the scale of Covid-19, you would have ridden the subsequent volatility and still had a pleasant investment experience. So even less-than-perfect conditions didn’t hinder positive return
From this small sample, you can see the message we seek to deliver: high yield is a resilient asset class that typically, through its income engine, delivers the yield it promises on the day, and can often deliver periods of excellent total return over shorter periods. For investors to receive their high-yield income without suffering offsetting capital losses, we need to assume defaults will be low. Despite high and rising interest rates, we do believe that default rates will remain low.
Global growth remains in pretty good shape. Supply bottlenecks are slowly easing and, in general, consumers have savings to cushion the blow higher prices and interest rates might have on consumption. Importantly for borrowers, the vast majority of indebted companies have pushed debt out into the future; therefore, there is very little refinancing risk. Indeed, inflation – within reason – can actually reduce defaults, as high yield companies with existing, long-term fixed rate debt should earn more, enabling that debt to be serviced.
Our process favours higher quality businesses within the high yield market, meaning we have a low proportion of companies with the weakest credit ratings. If we are wrong on our positive outlook for global growth, we have limited investments in cyclical sectors. Sectors like those tend to feel the squeeze most during economic downturns.
The best thing about bond market drawdown is you get higher yields on the other side. It is too early to suggest we are through this current bout of volatility. However, in our view, it is not too early to suggest high yield valuations are attractive at 6% yield for longer-term investors.
Key Risks
